the federal reserve system-its purpose and work || early functioning of the federal reserve system

American Academy of Political and Social Science

Early Functioning of the Federal Reserve SystemAuthor(s): Arthur ReynoldsSource: Annals of the American Academy of Political and Social Science, Vol. 99, The FederalReserve System-Its Purpose and Work (Jan., 1922), pp. 74-79Published by: Sage Publications, Inc. in association with the American Academy of Political andSocial ScienceStable URL: http://www.jstor.org/stable/1014513 .

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THE ANNALS OF THE AMERICAN ACADEMY THE ANNALS OF THE AMERICAN ACADEMY

job and would not hesitate to surrender it, if either business or politics should interfere with the independent exercise of their duties for the best advantage of the country as a whole.

If that is to be achieved, and the future of the Federal Reserve System is to be assured, the people themselves must take a hand. They must never fail to rally to the support of these faithful servants when unfairly at- tacked, and they must not lose any opportunity of showing them that their services are appreciated. If the people do not prove that they honor their leaders and stand by them loyally, what incentive is there for these leaders to hold out?

In a similar manner, Congress must feel that whoever dares to encroach upon the independence of the Federal Reserve System attacks the most sa- cred treasure of the people. In Wash- ington I came to know many upright men of the very highest type; never- theless a large number of our political

job and would not hesitate to surrender it, if either business or politics should interfere with the independent exercise of their duties for the best advantage of the country as a whole.

If that is to be achieved, and the future of the Federal Reserve System is to be assured, the people themselves must take a hand. They must never fail to rally to the support of these faithful servants when unfairly at- tacked, and they must not lose any opportunity of showing them that their services are appreciated. If the people do not prove that they honor their leaders and stand by them loyally, what incentive is there for these leaders to hold out?

In a similar manner, Congress must feel that whoever dares to encroach upon the independence of the Federal Reserve System attacks the most sa- cred treasure of the people. In Wash- ington I came to know many upright men of the very highest type; never- theless a large number of our political

leaders might prefer that the Federal Reserve System be subservient rather than independent. They want open doors for patronage and a ready com- pliance with the wishes of their con- stituents.

Protection for the Federal Reserve System must, therefore, not be expected from Washington, unless it is possible to arouse and strengthen the small number of distinguished men in the Admin- istration, and in Congress, who would understand the danger and would fight to ward it off. They will win if the country makes Congress understand that its heart is in it. If the people cease to exercise vigilance, if ever they relax in their insistence upon the integ- rity of their banking system, it may develop, as it did before, from the greatest blessing into the gravest men- ace. A Federal Reserve System turned into a political octopus, a national Tammany Hall, would infest not only the counting houses but every farm and hovel in the country.

leaders might prefer that the Federal Reserve System be subservient rather than independent. They want open doors for patronage and a ready com- pliance with the wishes of their con- stituents.

Protection for the Federal Reserve System must, therefore, not be expected from Washington, unless it is possible to arouse and strengthen the small number of distinguished men in the Admin- istration, and in Congress, who would understand the danger and would fight to ward it off. They will win if the country makes Congress understand that its heart is in it. If the people cease to exercise vigilance, if ever they relax in their insistence upon the integ- rity of their banking system, it may develop, as it did before, from the greatest blessing into the gravest men- ace. A Federal Reserve System turned into a political octopus, a national Tammany Hall, would infest not only the counting houses but every farm and hovel in the country.

Early Functioning of the Federal Reserve System By ARTHUR REYNOLDS

President, Continental and Commercial National Bank of Chicago

Early Functioning of the Federal Reserve System By ARTHUR REYNOLDS

President, Continental and Commercial National Bank of Chicago

ON October 26, 1914, the Secretary of the Treasury sent a message

to the twelve Federal Reserve Banks, then organizing, instructing them to begin definite operations on November 16, 1914. Great haste was made to secure adequate quarters and a working staff. One-sixth of the capital stock subscriptions were called on November 2, 1914, and on the sixteenth of No- vember the Banks formally opened for business.

"Regulation in ordinary times, as well as protection in extraordinary times" was the principle laid down by

ON October 26, 1914, the Secretary of the Treasury sent a message

to the twelve Federal Reserve Banks, then organizing, instructing them to begin definite operations on November 16, 1914. Great haste was made to secure adequate quarters and a working staff. One-sixth of the capital stock subscriptions were called on November 2, 1914, and on the sixteenth of No- vember the Banks formally opened for business.

"Regulation in ordinary times, as well as protection in extraordinary times" was the principle laid down by

the Federal Reserve Board in its first report after two months of operation, for defining the general scope of activities of the Federal Reserve Banks. There being no extraordinary times to call for the protective function as set forth in the above definition of policy, the operation of the Federal Reserve System during the first two years was confined largely to efforts, first, to "unify the banking system of the country" by seeking new members among the ranks of the state banks; second, to endeavor to regulate interest rates and equalize the demand for

the Federal Reserve Board in its first report after two months of operation, for defining the general scope of activities of the Federal Reserve Banks. There being no extraordinary times to call for the protective function as set forth in the above definition of policy, the operation of the Federal Reserve System during the first two years was confined largely to efforts, first, to "unify the banking system of the country" by seeking new members among the ranks of the state banks; second, to endeavor to regulate interest rates and equalize the demand for

74 74



EARLY FUNCTIONING OF THE SYSTEM

money by the purchase of bills and acceptances in the open market, and third, to establish a par collection system and the clearance of all checks on member banks.

The men charged with the operation of the Federal Reserve System, upon its inception, promptly sought to induce the banks of the country to make full use of its facilities. They were influenced, undoubtedly, by the feeling on their part that it was necessary to keep employed such funds as were entrusted to them in order to pay expenses and to earn dividends upon the capital stock. They felt that member banks should rediscount with the Reserve Banks, and by one means and another endeav- ored to accomplish this. But in the early history of the System it was des- tined to meet with no such ready response. The old banking practice of the country had its basis in too many years of actual habit, and it was but natural that banks generally should be hesitant and cautious in making radical changes in their methods; indeed, a great many of them felt that the Fed- eral Reserve Banks, if supported too generously, would ultimately encroach upon and usurp some of the functions of existing banks. They were loath, therefore, to go farther than the mere subscription of capital. It was inevi- table that a great many bankers in the country should look upon the System as a government undertaking and fear that transactions with it would be in- volved in "red tape." They feared also that it would be influenced by politics.

PREJUDICE AGAINST REDISCOUNTING

Coincident with this, and one of the greatest difficulties in the way of those who were ambitious for the quick acceptance of the System, was the long- time prejudice of bankers against dis- closing their borrowings to the public.

They had been educated to believe that deposits were the indication of strength, and that borrowed money was a sign of weakness. Any rediscounts or bills payable which they might lodge with the Federal Reserve Banks would appear in their statements, and since, in many instances, they could obtain credit from their city correspondents through methods which did not involve the direct obligation of their banks, and, therefore, did not appear as borrowed money, they were quite content to utilize the credit facilities of those city correspondents. It must be remembered that at this time there were no unusual conditions confronting the country; rates were low and money was easily obtainable. Bankers out- side of reserve centers had, over a con- siderable period of years, built up their relationships with reserve city and central reserve city correspondents. Those who had occasion to borrow for seasonal requirements were intimately acquainted with the city banks which had met their needs. Those banks which had for many years maintained balances with other banks felt that they had a cumulative asset of which they could avail themselves should the occasion arise. There was mutual understanding between correspondents, while the Reserve System was an un- tried departure.

It will also be remembered that the Federal Reserve Act did not make provision for the turning of all reserve funds over to the Reserve Banks. The change was gradual. Old relations between banks were, therefore, not interrupted.

All of these things militated against the fullest possible functioning of the System in its early stages, and such rediscounts and bills payable as were lodged with the Federal Reserve Banks were largely in the nature of "courtesy transactions" on the part of friendly

75



THE ANNALS OF THE AMERICAN ACADEMY

bankers who wished to help educate the banking fraternity to use the Federal Reserve facilities.

"COURTESY TRANSACTIONS"

Comment by the Ninth District Reserve Bank in its report for the year 1915 is illustrative of the general condi- tion confronting all of the Reserve Banks at that time:

During the latter half of November and the month of December, 1914, such rediscounts as were afforded members were largely courtesy transactions, the greater part representing the efforts of larger banks to acquaint the public with the new Federal Reserve currency. After January 1, 1915

. . loans dropped to the lowest ebb in many years. Rates on commercial paper took new low levels . .

The one great plaint during this time was the non-payment of interest upon balances carried at the Reserve Banks. In the report containing the preceding comment of the Minneapolis bank, Pierre Jay, Federal Reserve agent at New York City, said:

it is among the country banks as a class that most of the apathy and hostility to the Federal Reserve System which still persists is found. Their opportunities and earnings are relatively small and they must figure closely to live. They feel the loss of interest on reserve deposits; the absence, as yet, of dividends on their capital contribu- tions, and the prospective loss or decrease of the exchange they generally charge on remitting for checks drawn upon them.

The institution of the par collection system met with great disapproval from many banks in the smaller com- munities where the earnings derived from exchange charges had for many years constituted a comparatively sub- stantial part of the total earnings. Some banks sought to surrender their national bank charters and incorporate as state banks. This was only the forerunner of the more serious opposi-

tion encountered when the Reserve Banks undertook to make it compulsory upon all banks to accept their own items at par.

THE STATE BANK PROBLEM

The early attempts to obtain new members from the ranks of the state banks were bitterly opposed in many quarters. Legislation was even re- sorted to in combating the advances of representatives of the Federal Reserve Banks in this direction. In its second annual report on December 31, 1915, the Federal Reserve Board observed:

It is an unfortunate fact that, in some of the states, reserve requirements for state banks and trust companies have been mate- rially lowered by legislative enactment since the adoption of the Federal Reserve Act. . . . This is an element of danger in our banking system, because the weaken- ing of the reserves of the state banks and trust companies makes them more vul- nerable in times of emergency. . .. It would be deplorable were feelings of state or local pride to lead any of the states into competition with the Federal Reserve System such as would prompt them to lower their own banking standards or reserve requirements with a view of ena- bling or inducing state banks to refrain from taking membership therein. The Board is satisfied that state banks gain in safety and that states sacrifice none of their preroga- tives or powers when such banks become members of the Federal Reserve System, and therefore, expresses the hope that no seeming divergence of interest will be permitted to impede the establishment of higher standards of banking.

Every means was employed to make memberships in the System attractive to state banks and later amendments to the law aided in inducing them to join.

EARNING ASSETS BEFORE AND AFTER THE WAR

Failure to secure applications for rediscounts to employ more than a

76



EARLY FUNCTIONING OF THE SYSTEM

small part of the funds of the System, the Reserve Banks combined, from the caused the Reserve Banks to invest in date of opening to January 1st, 1921, government bonds, acceptances and gives a concrete picture of the early municipal warrants. A careful study functioning of the System in contrast of the graph on page 78 showing the to its operations after the United States curves of the earning assets of all of entered the War.

EARNING ASSETS OF THE FEDERAL RESERVE SYSTEM DECEMBER 31, 1914-OCTOBER 26, 1921

Bills discounted Bills bought in U. S. government Municipal for members open market securities warrants

1914 December 31......... 9,909,000 .... 205,000 734,000

1915 January 29........... 13,955,000 .... 2,015,000 11,165,000 April 30 ............. 2,774,000 18,812,000 6,813,000 18,656,000 July 30.............. 29,102,000 11,625,000 7,923,000 16,107,000 October 29.......... 30,448,000 13,619,000 10,505,000 25,014,000

1916 January 28........... 26,901,000 26,314,000 21,372,000 20,602,000 April 28............. 21,448,000 47,585,000 45,841,000 36,933,000 July 28.............. 27,594,000 83,454,000 48,656,000 27,220,000 October 27 ........... 21,131,000 86,085,000 40,469,000 29,890,000

1917 January 26........... 15,711,000 97,697,000 55,769,000 12,249,000 April 27 ............. 35,043,000 71,400,000 117,818,000 14,999,000 July 27 .............. 138,459,000 195,097,000 76,953,000 1,469,000 October 26........... 397,094,000 177,590,000 110,042,000 233,000

1918 January 25........... 627,632,000 273,912,000 123,194,000 4,902,000 April 26 ............. 901,743,000 302,844,000 78,853,000 ,722,000 July 26.............. 1,302,151,000 205,274,000 57,012,000 103,000 October 25........... 1,546,164,000 398,623,000 350,311,000 24,000

1919 January 31 .......... 1,601,128,000 281,293,000 294,784,000 4,000 April 25............. 1,950,412,000 185,822,000 218,636,000 July 25.............. 1,867,602,000 375,556,000 239,400,000 October 31 . .......... ,128,547,000 394,355,000 301,254,000 .

1920 January 30 .......... 2,174,357,000 561,313,000 303,521,000 April 30............. 2,535,071,000 407,247,000 293,514,000 July 30.............. 2,491,630,000 345,305,000 325,380,000 October 29 ........... 2,801,297,000 298,375,000 296,371,000

1921 January 28........... 2,456,475,000 165,058,000 287,320,000 April 27 ............. 2,063,739,000 103,609,000 267,792,000 July 27.............. 1,650,496,000 19,424,000 249,488,000 October 26........... 1,308,749,000 62,326,000 190,946,000

77



THE ANNALS OF THE AMERICAN ACADEMY

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78

_Y_



STATE BANKS AND PAR COLLECTIONS STATE BANKS AND PAR COLLECTIONS

The chart of the earning assets of the System demonstrates clearly that once the exigencies of the war period arose, there was no hesitancy upon the part of member banks to make heavy de- mands upon the facilities of the reserve banks. Indeed, as the momentum gained force, many bankers in their eager rush to meet the requirements of their customers lost sight of the earlier scruples concerning borrowed money and the pendulum swung to the other extreme. Instead of seeking rediscounts the officials of the System found themselves striving to conserve the financial resources of the country.

The general impression prevails that the War caused a development of the Federal Reserve Banks during the seven years of their operation that prob- ably would not have occurred in many times that number of years under other circumstances. Study of the early

The chart of the earning assets of the System demonstrates clearly that once the exigencies of the war period arose, there was no hesitancy upon the part of member banks to make heavy de- mands upon the facilities of the reserve banks. Indeed, as the momentum gained force, many bankers in their eager rush to meet the requirements of their customers lost sight of the earlier scruples concerning borrowed money and the pendulum swung to the other extreme. Instead of seeking rediscounts the officials of the System found themselves striving to conserve the financial resources of the country.

The general impression prevails that the War caused a development of the Federal Reserve Banks during the seven years of their operation that prob- ably would not have occurred in many times that number of years under other circumstances. Study of the early

functioning of the System bears out that assumption. The early operations of the banks also call to mind the point that they were less far-reaching in their influence. Business getting efforts are forgot or nearly forgot. But what was, may, perhaps, merely pre- sage what is to come. Under stable conditions, the Reserve Banks may make smaller profits, but they will not serve a less useful purpose. Commer- cial banking must respond to and reflect the activities of business. In times of great activity, whether seasonal or cyclical, the Reserve Banks will be called upon to meet a corresponding demand. In the usual process of business they will have recourse to open- market operations. Through these operations they may exert a great and important influence on the commercial banks, on interest rates and on business activity.

functioning of the System bears out that assumption. The early operations of the banks also call to mind the point that they were less far-reaching in their influence. Business getting efforts are forgot or nearly forgot. But what was, may, perhaps, merely pre- sage what is to come. Under stable conditions, the Reserve Banks may make smaller profits, but they will not serve a less useful purpose. Commer- cial banking must respond to and reflect the activities of business. In times of great activity, whether seasonal or cyclical, the Reserve Banks will be called upon to meet a corresponding demand. In the usual process of business they will have recourse to open- market operations. Through these operations they may exert a great and important influence on the commercial banks, on interest rates and on business activity.

The Federal Reserve System, State Banks and Par Collections

By PIERRE JAY Chairman and Federal Reserve Agent, Federal Reserve Bank of New York

The Federal Reserve System, State Banks and Par Collections

By PIERRE JAY Chairman and Federal Reserve Agent, Federal Reserve Bank of New York

FULL accomplishment of the purpose of the Federal Reserve Act,

to provide a means whereby the strength and resources of the numerous independent banks of the United States would be made effective for concerted or cooperative action for the protection of the banking system and the service of the nation's commerce, industry and agriculture, depended upon membership of a very consider- able proportion of the banks of the country. The provision of the Act making membership compulsory for national banks, brought at once into the System about 7,600 national banks with capital and surplus of $1,788,-

FULL accomplishment of the purpose of the Federal Reserve Act,

to provide a means whereby the strength and resources of the numerous independent banks of the United States would be made effective for concerted or cooperative action for the protection of the banking system and the service of the nation's commerce, industry and agriculture, depended upon membership of a very consider- able proportion of the banks of the country. The provision of the Act making membership compulsory for national banks, brought at once into the System about 7,600 national banks with capital and surplus of $1,788,-

000,000 and total resources of $11,- 492,000,000, thus giving a membership at the outset comprising 42.6 per cent of the total banking resources of the country. But the provision for the admission of state institutions was merely to the effect that they might, upon application, be permitted to become members, subject to regula- tions of the Federal Reserve Board, and should then have the rights and privileges of other member banks.

STATE INSTITUTIONS SLOW TO JOIN

Contrary to general expectation, the problem of state bank membership was found complicated. Most of the state

000,000 and total resources of $11,- 492,000,000, thus giving a membership at the outset comprising 42.6 per cent of the total banking resources of the country. But the provision for the admission of state institutions was merely to the effect that they might, upon application, be permitted to become members, subject to regula- tions of the Federal Reserve Board, and should then have the rights and privileges of other member banks.

STATE INSTITUTIONS SLOW TO JOIN

Contrary to general expectation, the problem of state bank membership was found complicated. Most of the state

79 79



the federal reserve system-its purpose and work || early functioning of the federal reserve system

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